Standard & Poor's Ratings Services placed its 'A-' rating on the Long Island Power Authority (LIPA), N.Y. on CreditWatch with negative implications.
"The CreditWatch listing reflects our view that recently passed legislation that the governor proposed, but has yet to sign, has the potential to erode LIPA's financial metrics," said Standard & Poor's credit analyst David Bodek.
The legislation subjects to full evidentiary hearings "any [LIPA] rate proposal that would increase . . . the aggregate revenues of the authority by more than two and one-half percent . . . on an annual basis." The legislation provides for New York Department of Public Service (DPS) reviews of rate adjustments effective on or after Jan. 1, 2016.
The utility believes that it retains ratemaking authority pending the January 2016 transition to DPS rate oversight. However, the state is requesting that the utility agree to a rate freeze through 2014 and possibly 2015. LIPA does not expect to adjust rates in 2013. It expects that the state will provide it with grant monies and relief from some payments to New York State during the rate freeze period to support its financial performance. LIPA's discussions regarding a rate freeze are ongoing.
The legislation's provision for rate hearings speaks to aggregate rates. The dichotomy between the utility's historical latitude to make unfettered rate adjustments through cost adjustment mechanisms while at the same time being subject to constraints on base rate adjustments created disputes, some of which were litigated. Standard & Poor's views the transition to a higher level of rate oversight, the regulatory lag that is typically associated with hearings, the contemplated rate freeze, and the implications it might have on financial metrics as capital spending proceeds and the utility faces inflationary pressures, in addition to the political hurdles to rate adjustments, as collectively having the potential to erode the utility's financial flexibility.
The legislation transfers much of the day-to-day oversight of utility operations to a subsidiary of New Jersey's Public Service Enterprise Group (PSEG). We believe the state's request that LIPA submit to a rate freeze shows that its high average rates of almost 20 cents per kilowatthour continue to pose an impediment to ratemaking flexibility; furthermore, the transition from the state authority's employees' oversight of a private company's management of daily operations to management by a private company does not ameliorate politicians' and ratepayers' negative perceptions of rates. We believe that a rate freeze, whether covering base rates, cost adjustment factors, or both, could deprive the utility of an important financial tool.
The legislation sets three days as the baseline for restoring service following emergency or storm events. If this goal is not met, the system operator must provide the DPS with an assessment of its pre-event preparedness and post-event restoration efforts. As the utility pursues the storm-hardening measures that the governor and legislators called for in the wake of the lengthy 2012 storm outages, the availability of ratemaking flexibility could be critical to supporting capital investments and preserving financial metrics.
Expectations that the utility will securitize portions of existing debt might improve credit metrics for the debt that it does not securitize. Call options and credit spreads will determine the amount of debt the utility securitizes and the cost savings it realizes. Based on other utilities' securitizations and discussions with management, we expect that the securitization bonds' debt service will appear on customers' electric bills. Therefore, while securitization debt might be viewed as a separate credit, depending on the elements of the securitization, nevertheless, its debt service might remain a consideration in setting rates if the utility's bills consolidate debt service on securitized and nonsecuritized debt, along with operating costs. Unless the securitizations' savings are substantial, the consolidation of securitization debt service on electric bills might do little to mollify customers' and politicians' negative perceptions of the high electric costs in the utility's service area.
On a positive note for the utility, the legislation will limit the growth of payments in lieu of taxes (PILOT) LIPA makes to municipalities. However, the utility's ratepayers will shoulder the cost of DPS oversight.
We believe that financial metrics have historically been only adequate for the rating. However, we viewed the financial flexibility the utility exhibited in its use of adjustment mechanisms and the service area's demographics as having compensated for thin debt service coverage and high leverage. The service area has more than 1 million customers and strong income attributes.
The authority's financing documents provide that PILOT payments are post-debt service obligations. Calculating coverage this way produced coverage of at least 1.4x since 2006, which we believe to be sound. However, because Standard & Poor's views recurring PILOT payments as having the attributes of operating expenses, we also calculate coverage that adds PILOT payments to operating expenses. We also treat fixed charge capacity payments to generation suppliers as debt service, rather than operating expenses. These adjustments reduced the income statement's accrual net revenue coverage to 1.1x in recent years, which we viewed as adequate. Based on an estimate of 2012's capacity payments, we calculated fixed charge coverage of 0.9x, which we consider to be weak.
Standard & Poor's generally excludes nonrecurring grant income from the debt service coverage ratio calculation's numerator. However, the grant income that LIPA reported on its income statement in recent years principally represented Federal Emergency Management Agency (FEMA) reimbursements for storm damage repairs that the authority expensed and U.S. Treasury reimbursements for a portion of gross interest on Build America bonds. Therefore, we included the grants in the coverage ratio's numerator. We also added the income statement's recovery of carrying charges on regulatory assets to the numerator. This money represents collections of debt service on bonds issued to finance a bill credit that coincided with the authority's inception.
The utility continues to maintain what we view as sound liquidity, with unrestricted cash and investments of about $380 million. Moreover, in June it received about $250 million from FEMA that reimbursed it for the $250 million it drew on its $500 million credit facility to pay storm restoration costs.
We consider leverage to be very high based on a 97% debt-to-capitalization ratio, which is especially high for a distribution utility.
Standard & Poor's expects to resolve the CreditWatch listing on an assessment of the legislative process's conclusion and developments relating to the rate freeze.
